February 23 , 2010

By Loughlin Cleary, Assistant Vice President, Relationship Manager

The current steepness of the yield curve makes it a good time for members to revisit the HLB Knockout advance. Let’s start by reviewing how the Knockout advance works. After the initial lockout period, the Federal Home Loan Bank of Boston automatically cancels the advance on the specified cancellation date if LIBOR is equal to or greater than a predetermined strike rate four London business days prior to the scheduled cancellation date.

As an example, a 5/1 (five-year maturity with a one-year lockout period) Knockout advance with a six percent strike rate can only be called on the specified cancellation dates — after the one-year lockout period — if three-month LIBOR is equal to or greater than six percent. Three-month LIBOR is currently at 25 basis points.

Currently, a 5/1 Knockout advance might be a cheaper alternative for funding extension than a five-year bullet advance because a member sells options when using a Knockout advance. Selling these options allows the Bank to call the advance.

Let’s compare the two advances. Currently, a five-year bullet advance rate is 3.18 percent, while an indication on a 5/1 Bermudan Knockout advance (callable quarterly after the lockout period) with a six percent LIBOR strike is 2.60 percent. The rate on the Knockout is 58 basis points lower than the five-year bullet. Currently at 25 basis points, three-month LIBOR would have to increase by 575 basis points before this advance could be called. With the steepness of the yield curve and a very low current level of three-month LIBOR, members may find value in the use of the Knockout advance. Members can choose the specific final maturity, lockout period, and strike level.

The Federal Home Loan Bank of Boston does not act as a financial adviser, and members should independently evaluate the suitability and risks of these advances. Please see the Knockout Advance Primer for a discussion of the risks and other considerations associated with the Knockout advance. We encourage you to review the risks and rewards of these advances and to consult your investment advisors about investment strategies that suit your risk profile and liability-management policies. Orders for Knockout advances of less than $10 million will be aggregated with other requests for advances with identical terms and will be executed when orders total $10 million.

For more details on the terms and conditions of the Knockout advance, please contact your Relationship Manger or call the Money Desk at moneydesk@fhlbboston.com or 1-800-357-3452.